Solvency UK – Adapting Solvency II to the UK insurance market

The PRA has proposed minor changes to the PRA rulebook to update definitions that encompass or refer directly to the onshored Commission Delegated Regulation (EU) 2015/35 (SII CDR).

The changes will ensure PRA rules refer to the SII CDR as amended by HMT’s statutory instruments (SIs). These draft SIs make provisions for the Solvency II RM to be reformed via transitional amendments to the onshored SII CDR.

The PRA is taking necessary steps to align the PRA Rulebook with the implementation of HMT’s RM reforms by 31 December 2023. Consequently, the consultation period for this section of the proposals closes on 31 July 2023.

The consultation on all the other proposals in CP12/23 close on 1 September 2023.

The transitional measures on technical provisions (TMTP) and the transitional measure on the risk-free interest rate (TMIR) smoothens the impact for firms of the transition from the previous Solvency I regime to Solvency II. With PRA approval, firms can apply temporary reductions to technical provisions for business written prior to 2016, increasing available capital.

The proposals in CP12/23 regarding transitional measures are summarised below:

• The new simplified default TMTP method would replace the existing calculation (the ‘legacy approach’) with the aim of reducing resource overheads for firms and the PRA while increasing consistency.
• Firms would be permitted to continue using the existing approach with some modifications in situations where the new approach materially changes the TMTP compared to the existing approach or create material operational impacts for firms.
• The financial resource requirement (FRR) test would be removed which could limit the amount of TMTP claimed by firms.
• All firms will be required to amortise TMTP so that it decreases in a consistent manner to zero by the end of the transitional period to 2032.
• The requirement for firms to seek the PRA’s permission for recalculation will be removed, allowing firms to calculate TMTP at the final day of each reporting period.
• Audit Committee oversight of the TMTP will be replaced by the Chief Actuary, alongside their existing responsibility for the Solvency II technical provisions.
• TMTP permissions outside of business transfers would not be permitted.
• Third country branches will no longer be permitted to use TMTP or TMIR.

For firms seeking permission to calculate the TMTP using the existing approach with some modifications, applications need to be submitted to the PRA by 30 June 2024, six months prior to the PRA’s proposed implementation date of 31 December 2024. Firms would then be required to monitor the eligibility criteria that permit the use of the legacy approach on an annual basis as part of the Own Risk Solvency Assessment.

The Solvency II framework allows firms to calculate their Solvency Capital Requirement (SCR) using the standard formula or an internal model, subject to approval from the PRA.

The proposals in CP12/23 regarding internal models are summarised below:

• Streamlining of the tests and standards that firms must meet for the PRA to grant permission to use an internal model. These will now be referred to as Internal Model Requirements.
• Introduction of greater flexibility in the way internal models meet the required standard, widening the circumstances under which it may be possible for the PRA to grant a firm permission to use an internal model.
• Where required, internal model approval safeguards would be set out in a written notice sent to the firm, the removal of which would require the firm to demonstrate that it had adequately remedied the underlying residual model limitation.
• Introduction of an internal model ongoing review (IMOR) framework consisting of four strands: PRA-driven thematic schedule, analysis of change exercise, assessment of ongoing internal model compliance and monitoring of safeguards.

Under strand 3 of ongoing compliance, firms would be required to provide an annual attestation to confirm that the internal model meets the calibration standards and Internal Model Requirements. The expectation is the attestation would be completed by an appropriate individual in a Senior Management Function, the Chief Risk Officer (SMF4) in most cases.

Whilst firms with existing internal model approvals are not expected to be granted new permissions, they should consider any consequential changes to their internal model change policies as a result of these proposals.

Capital add-ons (CAO) are supervisory powers exercised by the PRA which allow the PRA to increase the SCR to reflect a significant standard formula or internal model risk profile deviation, significant system of governance deviation, significant deviation from relevant assumptions or where appropriate a significant risk existing at group level. This is to ensure capital reflects the risk profile of the insurer or group.

The proposals in CP12/23 regarding CAO are summarised below:

• Introduction of a new type of CAO as a model permission safeguard, facilitating flexibility in the internal model permission process.
• Introduction of a new approach for calculating a CAO for an internal model significant risk profile deviation.
• Change in the frequency of the PRA reviews from at least annually to on a regular basis. The timings would be dependent on case-specific circumstances, including the materiality of the CAO.
• Introduction of regular reporting from the PRA summarising its use of CAOs at an aggregate industry level.

The proposals in CP12/23 regarding the Group SCR are summarised below:

• Temporarily permit firms to add the results of two or more different calculation approaches when calculating the consolidated group SCR.
• Allow a group to bring in its overseas sub-group’s SCR under method 2 of calculating group solvency where the sub-group is subject to equivalent group supervision. This would allow for diversification benefits between the method 2 entities within the sub-group.

Where international insurers operate in the UK through a branch, these are referred to as third-country branches.

The proposals in CP12/23 regarding third-country branches are summarised below:

• Removal of the requirement for third-country branches to calculate and report the branch SCR and branch minimum capital requirement (MCR).
• Removal of the SCR localisation requirement and the requirement to establish and report a branch RM for the purposes of ongoing supervision.

Third country branches would no longer be subject to dual capital requirements or the associated administrative burdens. Although third-country branches should note that the PRA will want to ensure that the branch’s home jurisdiction capital regime is broadly equivalent to the UK. If it is not, the PRA may adjust their supervision accordingly.

The proposed changes for reporting and disclosure under Solvency II aim to build upon PS29/21 and CP14/22 to reduce the overall volume and complexity of the requirements.

The proposals regarding reporting in this consultation are summarised below:

Removal of:

• the reporting requirement for the Regular Supervisory Report (RSR)
• the reporting templates relevant for third-country branches in relation to branch capital requirements, the branch risk margin and the localisation of assets to cover the branch SCR

Amendments to:

• reporting on home state resolution arrangements for third-country branches
• reporting requirements for groups to provide a centralised view of the overall SCR calculation
• reporting requirements on the TMTP to reflect the changes discussed above
• the Quarterly Model Change reporting requirements

Introduction of:

• new reporting requirements on the change in internally modelled SCR through the year
• new reporting requirements for insurance groups to report SCR at the level of the approved internal model, where multiple models are permitted
• new reporting requirements for third-country branches to report their legal entity solvency and financial position resulting from the removal of the branch capital requirements
• an extended scope of application of certain ‘national specific templates’ (NSTs) to cover third-country branches.

Whilst the primary focus has been on reforms to supervisory reporting the PRA may review other aspects of reporting and disclosure, including the Solvency and Financial Condition Report (SFCR) in the future.

The proposed transfer of the existing reporting requirements for third-country branches to the PRU rulebook will not materially change the scope of reporting that is applicable to third-country branches. However, it will change the legal form of the reporting to the PRA from an expectation to a PRA rule, which impacts how the PRA supervises non-compliance.

The PRA has also proposed to extend the solo and third-country branch quarterly reporting deadline by one working week to allow firms additional time to process technical information.

The PRA have set out their proposals for the new ‘mobilisation’ stage for new insurers. The proposals capitalise on the principles used for the banking mobilisation regime which has been adapted for the distinct nature of insurance risks and business models.

Mobilisation would allow firms to enter a mobilisation period of 12 months before full authorisation. During this time a new insurer would operate with business restrictions while completing the final aspects of its development.

The proposals in CP12/23 on mobilisation are summarised below:

• Firms in mobilisation stage would need to meet the Threshold Conditions and applicable standards set out in the PRA Rulebook and the FCA Handbook at all times.
• The absolute floor of the MCR at the mobilisation stage would be lowered to £1 million.
• Consent for authorisation of the new insurer would still be needed from the FCA.
• Firms would need to submit a mobilisation plan before being accepted into the mobilisation regime. The plan would need to outline an exit strategy if the firm failed to achieve full authorisation.
• Firms would be restricted in the business they can write during the mobilisation stage, with permission to write only a small amount of short-term and short tail business.
• Firms would need to apply for a variation of permission when exiting mobilisation.

Threshold limits determine whether firms are regulated under Solvency II or the non-Directive firm (NDF) sector rules.

The proposals in CP12/23 regarding NDFs are summarised below:

• The SII size thresholds relating to a firm’s gross written premium income will be increased and redenominated from €5 million to £15 million.
• The SII thresholds relating to firm and group technical provisions will be increased and redenominated from €25 million to £50 million.

Firms that fall outside of the thresholds would continue to be able to apply for a voluntary requirement (VREQ) to operate within the Solvency II regime where they do not wish to adapt to a different regulatory regime.

The PRA has proposed to redenominate the monetary values within the SII Firms sector of the PRA rulebook following the UK’s withdrawal from the EU.

The proposals in CP12/23 are summarised below:

• Redenomination of the absolute floor of the Minimum Capital Requirement (MCR).
• Redenomination of the threshold for a ‘material transaction’ the ‘Insurance – Supervised Run Off’ and ‘Run-Off Operations’ Parts of the PRA Rulebook.
• Redenomination of the quantitative thresholds for regulation under SII relating to reinsurance operations.
• Redenomination and specification of the amount a third country branch undertaking must hold on deposit as security in the UK.

The proposed rate under this methodology is £1 = €1.13, the average daily GBP/EUR spot exchange rate covering the 12-month period prior to 31 December 2020, rounded to two decimal places, with the resulting GBP values rounded to two significant figures.

Firms should understand the impact of the Solvency II reforms proposed in this consultation paper and plan for implementation including:

• A review of TMTPs under the proposed new calculation method to assess whether it results in a material change from the existing approach.
• Firms with approved internal models to update their internal model change policy to reflect the proposed changes.
• Firms to plan for new reporting requirements proposed in this consultation paper.

Firms who may have previously failed the tests and standards requirement for internal model approval may consider applying under the new flexible approach to internal model permissions.